Dogs of the Dow is an investment approach meant to produce higher returns than those earned by the Dow Jones Industrial Average market index. The concept involves identifying the 10 stocks with the highest dividend yield in the Dow. A high dividend yield suggests a stock's price is lower than it should be; therefore the stock is considered undervalued. There are variations on the strategy, but essentially investors allocate the same amount of money to each of the 10 "dogs" at the start of the year and continue to own those shares for 12 months.
The Dogs of the Dow system is most relevant at the start of the new year. The approach uses the closing stock price from the last day of the previous year to determine the dividend yield. A dividend yield represents a company's quarterly payout relative to its stock price. Companies can opt to pay dividends with their excess cash and generally do so on a quarterly basis. To find the dividend yield, the yearly dividend amount is determined by adding up the size of the quarterly dividends. The result is then divided by the stock price. The result is expressed as a percentage, and the 10 companies with the highest results are the Dogs of the Dow for that year.
The Dogs of the Dow approach is successful when its returns exceed those of the Dow Jones Industrial Average. Through the final days of 2012, the dogs produced returns of 10 percent, versus 7 percent for the Dow itself. Investment professionals have not always been successful using this approach. In 2009, the dogs generated an average return of 11 percent, much less than the 29 percent return produced by the remainder of the Dow in the same period.
Dividend stocks are often compared with government Treasury bonds. Both asset classes produce steady income and protect investors from some of the extreme price swings that other stocks can experience. When market conditions favor bond investing because of factors such as high interest rates, which is the rate at which bond interest payments are determined, dividend stocks might seem less attractive. As a result, investors may abandon dividend stocks, including the Dogs of the Dow, in favor of both the high returns offered in the bond market and nondividend stocks with rising stock prices,.
The Dogs of the Dow investment theory is adapted from the 1992 book "Beating the Dow," written by Michael O'Higgens. He labeled the top-10 dividend yielding stocks in the Dow as dogs because of their valuations. O'Higgens separated the dogs from the index in hopes of earning higher profits than the actual index when the stocks of the high-yielding dividend companies eventually reached a more fair and higher price.
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